Dealpolitik: The Good, the Bad and the Ugly of Class Actions

This is a story about class action lawyers who sued on behalf of millions of people who bought Dell, Apple and H-P computers with a faulty chip. Nvidia, the chip maker, took $509 million in reserves to pay for the defects. And when Nvidia finally settled, it said the litigation was a “causative factor” in pushing computer makers to extend their warranties on PCs. That is the good part of the story.

Then the lawyers settled. Beyond those extended warranties—the value of which was never quantified–here is how the statistics break down: Of the millions of customers who received notice of the settlement, only 28,355 submitted a claim for which they will receive total value of roughly $10 million.

Before the court knew so few claims would be made, the court approved $13 million in legal fees, supported by Nvidia along the way. Just so you do not think that is a typo, I will repeat that: The legal fees were $13 million. The settlement was $10 million. This is the bad part of the story.

And for that $13 million, in my view, the plaintiffs may have gotten world-class sloppy lawyering on a critical provision. Mistakes can happen to anyone, especially doing those last-minute changes. But presumably lawyers get paid millions not to make mistakes.

If you have read my prior post on class actions, you know I am somewhat ambivalent about them. And as ambivalent as I am about this outcome, you should know that I happen to be a member of this class. That is how I found out about this story. And I actually submitted a claim long before I knew about these details. More on that later.

Let’s go back to the beginning. The lawsuits started in California in about September of 2008. Seventeen law firms ended up being involved for the plaintiffs’ class.

The complaints alleged that there was a problem with the graphics chip installed in Apple, Dell and H-P computers.

For two years, the litigators did what they do best: they fought. Last summer the parties entered mediation. And guess what? They settled.

NVIDIA agreed to have the computer manufacturers replace the faulty chip. But at the last minute, when apparently there was lots of pressure to complete the deal, it was discovered that the H-P computers could not be repaired. So NVIDIA agreed to swap those computers for replacements.

But what type of computer would be provided? It appears the parties, rushing to sign up a settlement, could not agree on the precise details. Here is what the settlement agreement said (the emphasis is mine):

“…a replacement computer of like or similar kind AND equal or similar value will be provided to the consumer at NVIDIA’s expense. The Parties will meet and confer in good faith and agree on a suitable replacement of like OR equal or similar value.”

So which is it? “And” or “or”? Because as we all know, a three-year-old used computer is worth close to zero. If that were the sole standard, almost any computer would do. The class-action notice mailed to five million people used the “and” three times.

There was one last term in the settlement agreement. And it was quite well drafted. It provided the plaintiffs’ lawyers would receive a fee of $13 million from Nvidia and that Nvidia would not oppose the court’s granting the necessary approval of that fee.

In December, the judge approved the settlement and the fee after the plaintiffs’ lawyers told the court about the five million class members and Nvidia’s $509 million in reserves. The legal fee was compared to the amount of the reserves. The judge did not know how many claims would be made.

Bloomberg News

Ted Frank of the Center for Class Action Fairness tells me this is a frequent problem with class action settlements: Judges approve fees based on the number of theoretical claims, well before the actual amount to be paid is known. Although the lawyers took credit for the repairs and extended warranties prior to the settlement, no one seems to have pressed the parties to quantify those benefits.

Then, the lawyers negotiated on what replacement computer would be provided for those unrepairable H-Ps. It turned out to be a relatively low-end Compaq computer then selling at Best Buy for $330.

But guess what? Some people who buy computers actually understand computers and complained that there is no way this low-end computer was of “like or similar kind.”

And Frank from the Center for Class Action Fairness took a few of these people on as clients. Frank is a tort-reform advocate and spent four year as a resident fellow at the American Enterprise Institute. The purpose of his Center for Class Action Fairness is to give consumers who are covered by a class action settlement representation in objecting to an “extortionate settlement that fails to benefit consumers.”

And now Frank, Nvidia and the class action lawyers are in a nasty fight over what the ambiguous settlement agreement means and whether the offered computers are of “like or similar kind.” There is a hearing on March 28 that will settle that issue. Frankly, if you are like me, once they start to talk about single or dual-core chips and whether they are similar, the eyes start to glaze over.

Back to the issue of lawyering, though, here is something else Frank complains about: The class action lawyers actually represent Frank’s clients too. So why are those lawyers fighting him? Why didn’t they say “we think the computer we negotiated is fine, but if there is an argument our clients should get more we will zealously argue for that too”?

I should note that this has been a surprising windfall for me. My computer never worked quite properly and I never knew why. So after a year, it went into the pile of abandoned electronics my wife keeps telling me to toss, and I bought a new computer. I like the idea of getting a new $320 computer out of the settlement, of course. (Plus I get to tell my wife there is a reason to keep that pile of unused electronics.) But there is little social value in hearing “Honey, you were right.” So can any real good from this silly and expensive dance between plaintiff and defendant?

Unlike some people, I don’t think our litigation system is a lost cause. Causing consumer products companies to be more careful or public companies to be more honest to avoid this kind of nasty litigation is a laudable goal.

But the system is badly in need of reform. First step: We should discourage junk settlements. We might even have to pay successful litigants more. But we should start paying lawyers much less—or even nothing—when they do not produce significant value.

There was value delivered in this case. But I do not see how a $13 million fee is justified by 28,355 potential computer swaps or repairs worth around $350 a piece. Finally, remember how the judge approved the $13 million fee without even knowing the number of claims or their value? And Frank saying that is typical of class action settlements? That is nuts. Judges should not approve fees in class actions without knowing the value the plaintiffs collect. And here is an easy one: Contingent fee lawyers should not get paid before their clients!

This kind of reform is not likely to happen soon because everyone with a say is getting what he wants out of today’s system. The defendants get off the hook and the class action lawyers bank big fees. Even judges get what they want: the case off their docket.

But those who defend the status quo risk having too much of a good thing. Under the banner of tort reform, corporate America has long sought to eliminate the high costs of class actions. So far, the trial lawyers, who have a huge vested interest in the status quo, have proved too powerful in resisting meaningful reform. But if the trial lawyers continue to resist finding a way to put the right incentives into the system, the gravy train will eventually come to a screeching halt as even those of us who do see benefit in our litigation system give up on it.

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Ronald Barusch spent more than 30 years as an M&A practitioner at Skadden, Arps, Slate, Meagher & Flom LLP before retiring last year. He is no longer affiliated with the firm and the views expressed here are his own.

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